Iran: 5 key economic questions answered

The direction of the conflict in Iran is still far from certain. At the weekend the situation looked to be intensifying amid reports of further strikes on Gulf energy infrastructure, production cuts and hits on desalination plants. US reporting had even suggested that views were shifting on the possibility of US ground troops in Iran, albeit on a small scale. In summary, the risks of a more prolonged conflict looked to be rising. But President Trump’s comments in the last day have reignited hopes that the conflict may be short-lived.

For the White House, the military operation may be going to plan, but the politics is not. 
 

Were Iranian defiance and cost-of-living pressures underestimated?

President Trump may have been hoping that Operation Epic Fury would be a quick, shock and awe operation that toppled the Iranian leadership, cultivating a more compliant government which the US could work with, similar to what happened in Venezuela. However, the appointment of Mojtaba Khamenei as Supreme Leader of Iran has been viewed as an act of defiance, with Mojtaba seen as a hardliner in the mould of his father, and very close to the Islamic Revolutionary Guard Corps (IRGC). As such, there is little sign of the regime capitulating.

Secondly, Trump is starting to feel the pressure domestically and externally. The war in Iran was not supported by the American public to start with and given the sharp rise in energy prices, the cost-of-living pressures (which are the key interest for voters) are only set to rise. US gasoline prices have risen to $3.50 from $2.94 on 23-Feb. The Gulf states too have been airing their concerns, even warning that they may curtail foreign spending, potentially putting at risk the hundreds of billions of dollars they had pledged in US investments, something which had been lauded by Trump.
 

How are markets responding?

Crucially, it appears that the White House may have underestimated Iran's ability to conduct asymmetric warfare and the havoc it could play on global energy markets. Indeed, the sharp rise in energy prices this week may have revealed Trump’s economic pain threshold. Having played down rising energy prices last week, Trump’s tone changed in recent days; he suggested that the war could ‘end very soon’. Understandably, markets have reacted positively with Brent trading at $88/bbl having touched $119/bbl yesterday, before rising again. While there has been much criticism of the vagaries of US objectives in Iran, it may actually play out in Trump’s favour, allowing him to pave the way for a declaration of victory and an offramp to the conflict, which is generating more political problems than may have initially been envisaged. However, words need to be met with action and as at the time of writing the conflict continues. All parties would also need to agree to a cessation of hostilities, something which is not guaranteed at this point.

How long could energy prices remain elevated?

For global markets the critical issue remains the Strait of Hormuz, which remains effectively closed, Trump's threats of greater strikes on Iran and a proposed US Navy escort doing little to alleviate the situation. Hundreds of tankers and cargo vessels are now either trapped in the Gulf or in limbo outside the Strait, disrupting the transit of everything from oil and gas, to fertiliser and aluminium. The problem for energy markets is twofold, in that oil cannot leave the Gulf, but also that producers are having to throttle back production with storage nearing capacity. Estimates suggest that oil production has now been cut by 6-7mbbls/ day (c.6% global supply). The same, if not a bigger issue surrounds natural gas where Qatar, which accounts for the vast majority of the 20% of global LNG supply that comes from the Gulf has shut down production at its giant Ras Laffan complex. The problem with shutdowns is that even if the conflict were to end tomorrow and the Strait reopened, restarting production is not immediate. Qatar’s Energy Minister for example has suggested it could take ‘weeks to months’ to get supply back to normal levels. Therefore, the risk is that energy prices remain elevated for some time and with it the associated macroeconomic consequences.
 

How much will UK inflation be affected?

Arriving at an estimate of the macroeconomic impact of the conflict on UK inflation and GDP is not straightforward. This is because both the scale and the duration of the energy price spike will make a crucial difference, and these remain far from clear.

As regards the direct impact of higher energy prices on CPI inflation, two aspects matter: petrol prices and utility bills. The simpler aspect is the effect of higher oil prices on prices at the pump: pass-through of oil price moves is typically very fast and comprehensive. But for utility bills, the calculation is trickier. The gas bill component of the energy price cap is calculated based on the average level of natural gas price futures for a period of 12 months ahead, observed over a certain prior window, and with prices in certain quarters given a greater weight than others. As per the design of the energy price system, electricity prices, in turn, relate to gas prices. Because of this, a surge in gas prices that is expected to be short-lived will have quite a different impact on household utility bills than one that is expected to be sustained.

Based on where oil and gas price futures are trading at the time of writing (11 March 2026), we estimate this directly adds about 0.7%pts at its peak to our pre-conflict UK inflation forecast. This may be a plausible base case, but of course other outcomes are possible too, especially at such febrile times. A severe risk scenario could be one where the oil price spikes immediately to $150 and natural gas futures to 200p/therm, they both stay there through June and only gradually converge to current futures levels from the end of Q3. At its peak, this could see UK inflation 1.7%pts or so higher than the pre-conflict estimate.
 

What are the knock-on effects of higher inflation?

Such mechanical calculations though do not give the whole picture. The longer energy prices stay high for, the greater their indirect impacts on inflation can be, as firms adjust their output prices to higher input costs and households’ inflation expectations and wage demands risk rising too. Macroeconomic models can be a useful way for taking such comprehensive indirect energy effects into account on top of the direct effects. The Bank of England illustrated the sensitivity of its forecasts to an energy price shock due to geopolitical tensions much along the lines of what has now occurred in the August Monetary Policy Report. In this, it suggested a temporary global oil price jump of 10% would, at its peak, add about 0.5%pts to CPI inflation. Different modelling approaches gave quite different answers as to how much of a GDP impact there might be, but its baseline estimate was for a peak hit to the level of GDP of about 0.1%pt. With the actual oil price rise relative to the pre-war level about 30% at the time of writing, these figures should be trebled to arrive at what the Bank’s models would say.

Even then, the lesson from the Ukraine war has been that, in a world of deeply interconnected global supply chains, inflationary knock-on effects can come from the less obvious corners. For instance, we worry that it is not just oil and gas, but global fertiliser trade that usually passes through the Strait of Hormuz. If its flow is curtailed in the crucial planting season, harvests later in the year could have much lower yields, bringing about a later food price spike. And there have been warnings by the German health minister that cargos from India and China that are critical for the provision and production of medicines also typically use the same route, leaving these too vulnerable to potential shortages and price spikes in the event of a long blockage.

In short, financial markets have clearly calmed after a very tricky day in trading yesterday. An end to the conflict would of course be welcomed the most from a humanitarian perspective. But it would also help the world economy, certainly relative to the gloomier scenarios one can paint, even for economies far removed from the conflict such as the UK.

The implications for the UK may not be as stark as during the early stages of the Ukraine conflict, but another round of sharing the burden of the cost shock between households, firms and the government would certainly not be easy.